TFPD_06: Here we use guarantees. Here we use standby LCs

Trade Finance Paradigm #6: Here we use guarantees. Here we
use standby LCs

The next of the eight Trade Finance Paradigms is: Here we
use guarantees. Here we use standby LCs

Earlier this month I visited a customer, and they told me
that “here we use guarantees. Not standbys. And our guarantees are issued in
all kinds and forms; direct, indirect and for all kind of purposes.” I am sure
that if I visited a similar company in the US – the answer would have been the
opposite: They use standbys – not guarantees.

The approach that a company has to standbys and guarantees
differ around the world. People perceive things in different ways, and practice
evolves in different ways. Sometimes the practice becomes a paradigm. It seems
to me that the practice regarding the use of standbys and guarantees is a
paradigm: We do this or we do that – and we do it in so and so a way …. Full
stop! The practice has become a paradigm – and the paradigm blocks the way you
think … and that is when you must change your paradigm!

The fact is that although standbys and guarantees are
similar instruments – they work in different ways:

The traditional guarantee begins in the situation where a
guarantor issues an undertaking vis-à-vis a beneficiary. If the beneficiary
would like to obtain an undertaking from its own bank (a “local” guarantee),
this is solved by using a counter-guarantee. This means that the beneficiary of
the guarantee receives a guarantee issued by a bank (guarantor), even though it
is originally issued by the applicant’s bank (counter-guarantor). The counter-
guarantee indemnifies the guarantor in the event a complying demand is made (by
the beneficiary) under the guarantee. The counter-guarantee and the guarantee
are two separate guarantees, independent of one another. (I am sure that for
the untrained ear this sounds like nonsense :-)

In similar circumstances using a standby, the standby is
confirmed by a confirming party. I.e. the standby is issued by the issuer – and
advised to the beneficiary by a confirmer. The ISP 98 rules state that the
“issuer” includes a “confirmer” as if the confirmer was a separate issuer and
its confirmation was a separate standby issued for the account of the issuer
(ISP 98, Rule 1.11(c)). There is only one instrument, but two parties (issuer
and confirmer) obligated under it.

In other words: two similar instruments – but two different
structures to solve the same issue.

So which is best? I am sure that this question can be
debated for ages – and for sure you can argue both ways. The point I am trying
to make however is that since the two instruments do not have the same
structure, they will fit into the transaction that they are to support in
different ways. Sometimes better. Sometimes worse. It all depends on the
structure of the transaction. For that reason it makes no sense being “locked”
to one of the instruments. A company with an open and holistic view as to
choice of instrument surely can choose the instrument that best suits the
specific transaction.

So my advice would surely be for banks and corporate
customers to forget about how they use to do things; including which instrument
they suggest/use – and start suggesting /using the more appropriate instrument
for the specific transaction.